Yesterday the Bank of England Monetary Policy Committee (MPC) increased the base rate by 50 bps, a hike that is double the size expected just two days ago. The MPC has clearly been spooked by news earlier in the week that headline CPI inflation unexpectedly remained unchanged at 8.7% in May, and core inflation increased to 7.1%. Rising core inflation, which excludes volatile items like food and energy, is of particular concern as it smacks of the situation getting away from the MPC, with consumers and firms baking in high inflation into their future expectations.

The advantage of the bigger rate hike is it sends a clear message to consumers and markets that the Bank is determined to lower inflation. However, the downside is the increase will further heap pressure on debtors, and there is growing concern that after thirteen rate hikes since December 2021 many households now face sharp rises in mortgage repayments when their existing fixed rate deals expire. The Institute for Fiscal Studies estimates that mortgage holders are facing an average 8.3% fall in their disposable incomes due to rate increases in the last year, and as many as 1.4 million households could see a drop of over 20%.

There is now an urgent need to bring UK inflation under control, which is looking like an outlier among major international economies, given it is at 4.0% in the USA and 6.1% in the Eurozone. Therefore, we believe over the summer the MPC will now steadily increase rates further to 5.25%, possibly even 5.50% if the inflation data continues to disappoint. We also suspect the Bank may consider stepping up Quantitative Tightening (the opposite of Quantitative Easing) thus utilising a different tool for fighting inflation beyond interest rates.

Whatever the Bank of England does to fight inflation will inevitably have the effect of dampening economic growth, which currently is marginal – just 0.1% in Q1 2023. This increases the likelihood the economy could see a technical recession at some point later this year. We see the consumer side of the economy as looking particularly vulnerable, given mortgage payments are set to rise and pay growth is currently negative in real terms and has been for some time.

For the property market, the main concern is the lack of certainty on where interest rates will ultimately go. Just a couple of months ago, the consensus view was that rates were either at or close to their peak, a situation that was encouraging many in property to ask the question: is now the time to re-enter the investment market? However, a revival of the rate hiking cycle, with no one truly certain of how far away we are from the peak, will encourage many property investors to return the side lines to monitor events, at least for the time being.

Also, higher rates further increase the likelihood that some landlords find themselves unable to economically refinance debt, and thus have to sell assets. This could though be a mixed blessing as it will accelerate the repricing process, and tempt back into the market those with significant dry powder waiting for the right time to deploy.

We believe the property market will see a turning point later this year, once there is clarity on trajectory for interest rates. However, that turning point has moved a few months further into the future, and is looking unlikely before the autumn.